The first month of 2024 wasn’t a strong one for the Lloyds Banking Group (LSE:LLOY) share price. An 11% decline since the start of the year means the stock is closer to 40p than 50p.
At a price-to-earnings (P/E) ratio of around seven, though, shares in the UK’s largest retail bank look cheap. So why does the price keep falling?
Loan defaults
A couple of reasons come to mind, but the biggest of them is loan defaults. According to a Bank of England survey, lenders are expecting the sharpest rise in missed repayments since 2009.
Should you invest £1,000 in 95841 right now?
When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if 95841 made the list?
To some extent this isn’t a huge surprise. Inflation has been causing the cost of living to rise and higher interest rates mean that financing this with debt has become more expensive.
This has meant households that were getting by with prices lower and debt cheaper are finding their budgets under pressure. And in more and more cases, this is getting to breaking point.
As a result, defaults on mortgages rose significantly during the last three months of 2023 and are expected to continue. It’s not just home loans either – something similar is true of unsecured debts.
Even with the mortgage market stabilising to some extent in anticipation of interest rate cuts, demand is still very low. None of this is good for profitability at banks such as Lloyds.
A buying opportunity?
Lower profits aren’t a good thing for shareholders. But in theory, Lloyds shouldn’t be facing an existential threat here — it ought to have provisions that can cover rising defaults, so I don’t see a crisis for the bank.
The trouble is, simply staying in business isn’t good enough. For equity investors, Lloyds needs to generate enough cash to justify an investment given today’s share prices and this is less clear.
Earnings are going to be lower this year, but it’s not clear what the extent of the damage will be. And in cases like this, investors often try to err on the side of caution.
Once the scope of the losses becomes known, the market should be able to figure out what the Lloyds share price should be. But until then, the stock might well have further to fall.
There might be a buying opportunity here, but getting an accurate read on the risk is very difficult. Nonetheless, I think there’s a strategy that investors can follow.
Margin of safety
According to Warren Buffett, investing well involves insisting on a margin of safety. This means buying shares only when they’re obviously cheap relative to the company’s earnings prospects.
In other words, it needs to be obvious enough that the only question is how much it’s underpriced, not whether it is. And I’m not sure that’s the case with Lloyds at the moment.
From my perspective, it’s difficult to know whether this year’s earnings per share are going to come in at 3p or 6p. And with a share price around 42p, that makes quite a difference.
Lloyds shares look cheap based on last year’s earnings. But this year looks like it could be much more challenging, so I wouldn’t be surprised if it turns out that the stock has further to fall.
